FISCAL POLICY AND AUTOMATIC STABILIZERS : WHAT MANAGERS NEED TO KNOW - PowerPoint PPT Presentation

CHAPTER 13 FISCAL POLICY AND AUTOMATIC STABILIZERS : WHAT MANAGERS NEED TO KNOW TEAM 3 : LEXI GRAVINO - Age aint no thang cause Im gonna do it anyway TIFFANY VEREEN - Med is my business , blood hands and balance sheets TAYLOR DURAND - TD - all I do is score no matter what NICOLE HORTH - Force from the North KARA SHANNON - Im not a playa , I just ACT a lot ANDREW GLOECKNER - Just along for the ride

FISCAL POLICY Discretionary and non-discretionary use of government spending and taxation policies to achieve macroeconomic goals

FISCAL POLICY VS. MONETARY POLICY

GOVERNMENT SPENDING Government spending & taxation includes ALL levels of government (national, state, local, cantonal) National governments receive revenues from individual and company income taxes, tariffs, and user fees

U.S. GOVERNMENT SPENDING Largest portion of government spending is on Health and Medicare, SS, and Defense

BUDGET DEFICITS Deficits: governments spend more than they earn in tax revenues and fees per period Government tap the financial markets by issuing securities with varying maturities Securities issues by a national government can be purchased by virtually anyone in the world Concerns are raised when an increasing portion of a nation’s government debt is purchased by foreign residents

THE FISCAL MULTILPLIER Fiscal Multiplier: the spending multiplier when the source of an external shock is a discretionary change in government expenditure or taxation Major Forces that Weaken Fiscal Multiplier: Automatic Changes in Tax Revenues, Government Transfers, and Imports Higher real risk-free interest rate increases the quantity of foreign funds supplied to the domestic real loanable funds market.

CROWDING-OUT Crowding-out: occurs when government borrowing raises the real risk-free interest rate and reduces private borrowing. Therefore, a rising real risk-free interest rate crowds out individuals and businesses,rather than the government, from the real loanable funds market. Outward demand shift Inward supply shift

CROWDING-IN Crowding-in: increase in private Construction of a new highway investments caused by greater Encourages business growth along government spending and its impact, road which strengthens the fiscal multiplier Strengthens the Fiscal Multiplier

GOVERNMENT SURPLUS Surplus: governments spend less than they receive in tax revenues and fees When taxes exceed spending, the government is often viewed as taking more away from aggregate demand than it contributes. Increase supply of loanable funds

ACTIVE DEFICITS & PASSIVE DEFICITS & VS SURPLUSES SURPLUSES Active deficits are expansionary, active Passive deficits are caused by the automatic stabilizers. surpluses are contradictory, and balanced active budgets are neutral Automatic Stabilizer: expenditures & taxes respond passively to the changing economic *play an important role in stimulating or conditions and calm fluctuations in both real dampening economic conditions GDP and prices that would have occurred without them Government Transfers: non-discretionary changes in government expenditures **ONLY restrain economic activity NOT an independent source of economic change

FISCAL POLICY IN ACTION Discretionary Fiscal Policies are most effective when they are used to solve demand-related problems (short term solution only) IF INFLATION IS SPIRALING UPWARD: -Government can reduce spending to directly trim aggregate demand and curb the inflation -Tax rate hikes are another way to reduce a nation's aggregate demand CONTROVERSIAL: - People take it personally - Past legislations often lock in expenditures

LAGS IN FISCAL POLICY RECOGNITION LAG: The time it takes to recognize that a fundamental change in the economy has occurred (3-6 months) Implementation Lag: The time it takes to implement the fiscal policy (3 months-2 years) IMPACT LAG: TOTAL LAG TIME: 9 MOS - 3.5 YRS Time it takes for policy changes to take effect (3 months-1 year)

DOWNSIDE FOR FISCAL & MONETARY POLICY LAG TIMES The legislative policy could have changed from a cure to a policy toxins Controversial about the effectiveness of discretionary fiscal spending due to its long and variable lags

MONETARY EFFECTS OF FISCAL POLICY Central Bank's Balance Sheet Rises: -Bank purchases assets (less cash) -Central Bank's Balance Sheet Falls: (Retiring Monetary Base) -Bank exchanges assets for monetary funds (more cash)

WHEN ARE GOVERNMENT DEBTS & DEFICITS PROBLEMS? Deficits & Surpluses: flow measure Debt: Stock Measure Business: Success is measured by how fast stockholders' equity increases Borrowing = support investments Similar concept with the governemnt & investing Large Governemnt Debt? Dont worry. The asset of any individual, company, or government MUST equal the sum of liabilities and stockholders’ equity

WHEN ARE GOVERNMENT DEBTS & DEFICITS PROBLEMS? Governments and companies technically have an unlimited lifetime Implications of debt free Government If US government immediately repaid trillion-dollar debt since would be the biggest redistribution of income in the history of the world Treasury securities would not be bought by investors because they are no longer risk free Re-purchase treasury bills Print more money or increase tax Money moves from tax payer to security holder Government investments increase a nation’s net well-being ONLY if they produce goods and services with greater value than the private sector Education, vaccines, national defense, law enforcement Possibility of default: borrowing by issuing securities denominated in foreign currencies Cant pay back debt with printed currency or capture via tax

Changes in a Government's Balance Sheet How can a Government measure its Assets if Equity is growing? National Balance sheet Change in Equity > Change in Debt measuring economic health International Comparison: Government Gross-Financial-Liabilities-to-GDP Ratios for Developed Nations in 2013 Debt to GDP ratios are a good measurement of debt US debt is creeping to levels normally associated with European countries as of 2013

CROWDING-OUT: WHEN IS IT COMPLETE, NONEXISTENT, OR Amount of crowding out from Gov spending depends on supply & demand elasticities PARTIAL? Real loanable fund market Top Left Supply perfectly elastic (Horizontal) Change in demand No affect on real risk free interest rate Affects Equilibrium Top Right Supply perfectly inelastic (Vertical) Change in demand Affects real risk free interest rate No affect equilibrum Center Supply sloaping upwards elasticity in-between zero and infinity

SEPARATING ACTIVE AND PASSIVE DEFICITS & SURPLUSES 1) Calculate how many people would be employed if the nation were at full employment 2) Calculate GDP per person and how much more GDP would be produced at full employment

SEPARATING ACTIVE & PASSIVE DEFICITS AND SURPLUSES 3) Calculate the automatic change in government transfer payments and taxation if the nation was at full employment 4) Calculate the active and passive deficit/surplus, and draw your conclusion

A CLOSER LOOK AT THE MONETARY EFFECTS OF FISCAL POLICY The monetary base changes only when a central bank crosses an imaginary horizontal line -Financial intermediaries are below the line -The central bank is above the line Central banks are the financial agents of their governments

Monetary Effect of Taxes Everyone knows about paying taxes BUT where do your funds go? -There are two options: Financial intermediaries or Central bank -The government generally keeps them in the intermediaries to avoid large reductions when taxes are paid and an increase when government expenditures are made

Monetary Effects of Government Taxes -Taxpayers transfer $10 Billion to government -Hold the funds at financial intermediaries in Tax & Loan accounts(T&L) -T&L rises by $10 billion -Taxpayers decrease by $10 billion -There is a change in the ownership of deposit liabilities Tax payments have no effect on a nation’s monetary base because all the transactions are below the line (in the intermediaries)

Monetary Effects of Government Transfers **(Right now assuming government treasuries hold all their deposits in financial intermediaries) -Government transfer $10 billion to central bank from intermediaries -The monetary base decreases by $10 billion -The financial intermediaries lose $10 billion of deposit liabilities -Will also lose an equal amount of reserves in the form of deposits at the central bank -The transfer of funds is independent of the public’s payment of taxes -Government Deposits at the Central Bank since they still need to write checks on & make wire transfer -They perform finance services; such as tax collection, issuance of new debt, and administration of payments on outstandingdebts.

Monetary Effects of Government Spending -Government spent $15 billion on a new highway -The T&L account will fall by $15 billion -Highway contractor’s account rises -The reserves financial intermediaries and the monetary base would remain unchanged Government spending has no effect on the nation’s monetary base because all transactions are below the line